Last week was certainly one for the bulls, and with an eye on any sort of escalation from geopolitical clashes over the weekend, Friday added to the already hot temperatures of oil prices allowing both M1 WTI and Brent to achieve 6-month high levels. Even after giving some of their gains of the day away, all of the recognised contracts performed in very positive fashion and finished, on a weekly basis, higher than the previous one. WTI registered a gain of $3.75/barrel (+4.50%), Brent $3.69/barrel (+4.22%), Heating Oil 15.74c/gallon (+6.02%), RBOB 2.75c/gallon (+1.00%) and finally Gasoil $53.50/tonne (+6.55%). For those of a technical analysis and bullish disposition it will be heartening how the market is lining up targets higher, and successfully breaching them. Yet, this move owes little to the mathematics of how dots and plots register on charts and is more to do with financial positioning, fear of escalating conflict and a narrative that once again incurs heady $100 calls for crude oil prices, and for believing ears with a touch of ironic hyperbole, that the world is about to run out of oil.

Oil is more attractive for funds

For the first quarter of 2024 and let us use Brent as the example, for it is the marker crude, the North Sea basket registered a gain of 13.55%. But bearing in mind it lost 19.17% in the fourth quarter of last year, if Brent were a pupil at school its head teacher’s report might include the charge of being an underachiever. In comparison and using the US bourses as they are the most watched and traded, Nasdaq is up 20.05% in the last 6-months, the S&P500 is up 20.04% and even the DOW Jones is up 15.77% in the same period and does not directly benefit from the Artificial Intelligence jamboree that fuels the more tech-sensitive indices. Brent in the last 6-months has achieved a lowly increase of under 3.5%, and counterintuitively is one of the reasons it is becoming more attractive to the monied ones. Not that fund managers trade in the same way as amateurs with penny-shares, it is not just a punt and hope that one of a myriad of picks will be the next Nvidia, no, commodities have become more attractive and stocks a little less so because of our old favourites, inflation and interest rates.

Taking a broad-brush approach by accepting that money flows usually increase in times of stock market gains and at present are exacerbated by the extraordinary profits from the AI mega-caps, underperforming instruments in a shifting economic environment become not only increasingly viable but logical as destinations for fund placement. Arguably, there are four main reasons why Brent is more attractive as an investment tool for institutional investors, rather than just CTAs or short-term asset traders. The big-ticket money looks first for a trend, and in Brent there is now nigh on a 2-month straight rally. With that trend, a favourable backwardation is an added attraction and although not always necessary, it is something of a profit and loss bonus when it comes to rolling contracts forward. But at present, and more importantly for commodities in general, are inflation and interest rates. There is something of paradox going on as the inverse relationship between the US Dollar and commodities unwinds, none more prevalent than what is happening in Gold. Admittedly, Gold has caught a bid as it often does during Middle East strife, but the rally in no way has been cowed by a resurgent US Dollar made more attractive by an increasing belief that the FED will be hamstrung in trying to bring in a rate cut at any point in 2024. Higher interest rates will be a hinderance to refinancing in technology stocks which may see a loss of sheen, and any migrating monies will have to land somewhere. A little of that somewhere might be oil, for as just suggested interest rates might not move because of the sticky state of inflation. Oil on the one hand might be a cause for inflation, but it certainly offers a hedge against it and one that seems to be attracting similar thinking in recent times as open interest increases along with net long positions from money managers.

Fund length offers correction risk and maybe opportunity

Bullish Brent positioning has increased by 9,866 lots from the money manager category according to commitment to trade data published by ICE on Friday. This brings net-long positions to 299,835, the largest for over 13-months, with long-only up 9,090 lots to 370,008 and a 2-year high. These data act in affirmation of an increasing interest from institutional investors, but however, offer something of a problem for those that are expecting an unimpeded rally. Many funds adhere to the S&P GSCI fund parameters as to when they roll positions forward. The roll starts on the fifth trading day of the month and lasts for 5-days. Obviously, their effect is seen largely on nearby spread values and sometimes flat price, but the influence will be all about the size of the current exposure that the many funds that comply with the GCSI format currently hold. The day before the roll started last month the M1/M2 Brent, namely May/June was $0.78/barrel, on the last day of the roll it was $0.48/barrel at the close, and although the market subsequently went on to rally hard, day 1 of the roll to day 3 of the roll saw May flat price lose around $2.45/barrel high to low. Net-long positions at the time of the last roll were 236,805 lots and the long-only positions were 312,562 lots, therefore with a much-increased length presence in the market one might assume a heavier amount of rolling this time around.

US, Israel, Gaza and Iran

What might make the rolling seem heavier in the next few days is that those that trigger any position shifting may have felt obliged to stay their hand for one day of the period because of the approaching weekend and the fear of something untoward happening. This became particularly acute after the CIA, for reasons outlined below, warned on a retaliatory impending attack on Israeli assets/embassies by Iran.

After the disastrous IDF strike on an aid convoy in Gaza, the language between the US and its staunch protectorate, Israel, had turned somewhat frosty. However, there is demarcation in the US attitude to the awful civilian treatment of Gazan citizens by Israel forces and the proxy war that is engaged between Israel and Iran. Howsoever the US acts to stop tens of thousands starving in Gaza, it will be treated as a separate issue and will not bring about a change in its shared belief with its ally that Iran is an existential threat to the Israeli state. Whatever the US might say or do in terms of Gaza, it will not allow any enemy of Israel to believe that Uncle Sam is about to pull the rug. Hence the CIA warning and why initial language of admonishment is always finished with reassurance, as seen from the White House national security advisor John Kirby yesterday. Reported in the Guardian and aping President Biden, Kirby said, “We’ve got to see changes in the way they are prosecuting these operations and we’re going to have to think about making changes in our own policy toward Gaza.” But he said, “We have to remember that Israel has a right to defend itself and it is important to remember they live in a tough neighbourhood.” Whether this morning’s reported IDF withdrawal indicates a more sympathetic ear, or that Israel smells a proxy attack from the north is debatable, but the current talks in Cairo are offering no new breakthrough according to Hamas representatives.

Oil prices are about to see a swinging week, made harder to predict by the confluence of influences such as those listed above. We still believe that the market at present does not have enough about it physically to warrant a charge beyond $90/barrel to $100. But given the tinderbox nature of the current geopolitical crisis arenas of the Middle East and Ukraine/Russia and a keener interest from big money, the downside potential is also limited at present. Once we have sorted all this out over the next couple of days the small matter of the US CPI lies in wait for all markets on Wednesday.

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